The ferrous complex lifted aggressively yesterday as green restrictions on steel output rocket prices higher. Iron ore had a better day but China aims for it to be the charred remain left behind. Will it succeed?
Morgan Stanley tackles the question:
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Summary view: China’s steel production cuts are positive for global steel prices, but will pile pressure on the still elevated iron ore price. Our forecast implies downside to forward iron ore prices. We expect high-grade 65% Fe ore to outperform lower quality ore. Strong ex-China steel production should push met-coal higher.
China’senvironmental steel cuts could tighten thesteel market…China appears to be starting a new supply reform program, aiming to reduce industrial pollution. The authorities in Tangshan – where 14% of China’s steel is produced – have ordered steel mills to cut production by 30-50% until year-end. We now expect China’s steel production to decline between 0.3%-2.3%yoy in 2021, instead of another year of growth,and expect its finished steel exports to fall by 30-50Mt yoy. This will tighten the seaborne steel market significantly, and require higher rsteel prices before ex-China producers lift production.
…but means headwind for iron ore. With c. 75% of seaborne iron ore demand coming from China, Tangshan’s steel cuts will have a disproportionate impact on the iron ore market.
We now expect a balanced seaborne iron ore market on a full-year basis in 2021,vs a deficit market previously. We forecast $160/t in 2Q21,as higher steel prices are likely to provide some near-term support, but see a significantly lower iron ore price of $100/t in 4Q21.
We expect high-grade 65% Fe iron ore to outperform lower grade58% Fe ore. With China’s steel production restricted, but still healthy underlying demand, steel mills will be looking to maximize their productivity, and prefer the use of quality iron ore.
Metallurgical coal will benefit from the recoveryin exChina steel production. While iron ore is coming off a high, the price of the other key steelmaking ingredient remains relatively low. Seaborne met-coal is much more exposed to the ex-China market than iron ore is. This year’s strong rebound in ex-China steel production (MSe +99Mt; +12%yoy) should push the met-coal price up, from the current lows caused by China’s import ban on Australian coal. We forecast an Australian hard coking coal price of $140/t in 4Q21.
In the energy space we prefer uranium over thermal coal, but this is a longer-term theme. With uranium supply continuing to fall short of utility demand, we see inventories eroding further, gradually pushing the price higher.
Sure. But this only works if China’s mills have good stocks of iron ore and they don’t. So, in the short term fattening steel margins trigger raw material restocking and prices rise of iron ore as well.
This is why I prefer to reference apparent, not underlying demand. As stocks rise, demand cools, supply returns, and seasonal weakness strikes we will see the price deck drop.